Mon, 20 Apr 1998

Bank restructuring

Bank restructuring takes up the largest portion of the 117- point supplementary reform package that was agreed between the government and the International Monetary Fund on April 7, for an obvious reason. The ailing banking industry is one of the central roots of the causes of the economic crisis and the cost of bank restructuring is also the largest among the reform measures.

The supplementary package estimates the total cost of bank restructuring at Rp 155 trillion (US$19.4 billion) or 15 percent of gross domestic product. Around Rp 80 trillion of the total has been injected as liquidity credits to ailing banks. The other Rp 75 trillion will be used to strengthen problem banks currently under the management or close supervision of the bank restructuring agency (IBRA). These crippled banks include the seven suspended early this month, seven more put under the management of the IBRA and 40 others under the close supervision of the agency.

So huge have been the funds pumped by the central bank into the banking system that many banks apparently have so far been hanging like dank corpses, unable to lend and able to survive only through government handouts and Bank Indonesia's printing presses. This condition once again testifies to how urgent it is to enact a proper bankruptcy law. Without proper insolvency and liquidation procedures, the economy will continue to accumulate a stock of unproductive assets like the crippled banks.

The huge fund injection also shows how the central bank has dangerously overextended its function as a lender of last resort. As the case of the seven banks already suspended and seven more put under IBRA management shows, the almost Rp 30 trillion in liquidity credits pumped into these 14 banks proved to be ineffective in restoring them to sound operations.

Bank Indonesia's lender-of-last-resort facilities are meant to support only illiquid but solvent banks and not insolvent ones and to prevent banking panics and runs. But the central bank seemed so preoccupied with the prevention of another wave of bank failures after the November closure of 16 banks that it has showered almost all problem banks, including insolvent ones, with liquidity.

This "panicked" liquidity injection, without first thoroughly assessing the problems and the quality of the banks' assets, might have been prompted partly by the blanket guarantee provided by the government for the claims of depositors and creditors on all locally incorporated banks since late January.

The central bank seemed to lack reliable information from its supervisors as to which of the banks were approaching insolvency and which ones were already insolvent. Indiscriminate injections of liquidity credits to ailing banks causes moral hazards because the closer a bank is to insolvency the stronger are the incentives for the management and owners to hide information from supervisors and the market.

Finance Minister Fuad Bawazier's statement last week that the 14 crippled banks would still have to be subjected to due diligence to ascertain the responsibility of their management and owners strengthened our concern that both the central bank and IBRA still seem to be in the dark about what the real nature and extent of the distressed banks' problems.

IBRA should avoid the central bank's costly mistakes in the handling of the seven suspended banks and seven others under its management. It should act firmly and quickly in assessing which of the 40 other distressed banks currently under its close supervision are still bailable and which ones should be suspended.

The parameters used by IBRA as the threshold for suspending banks -- those receiving central bank injections equal to more than five times their equity or 75 percent of their assets -- and the threshold for putting banks under its management -- receiving injections equal to more than five times its equity or more than Rp 2 trillion per bank -- seem too lenient.

We are afraid the management and owners of a bank which already owes the central bank or IBRA more than five times its own capital no longer has the incentive to restore their bank to a sound footing. Nor do they see any big risks of further dissipating whatever assets their bank still has.

Injecting liquidity to ailing banks without first assessing their assets and their prospective business viability amounts to throwing good money after bad at great expense to the taxpayer. The haphazard manner and snail's pace at which the central bank is deciding to transfer problem banks to the IBRA "hospital" might overwhelm this agency with many banks with worthless assets. IBRA also might eventually be overloaded with too many ailing banks for which it will not have enough qualified managers.